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What Determines the Direction of Technological Progress?* Defu Li1

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What Determines the Direction of Technological Progress?* Defu Li1 What Determines the Direction of Technological Progress? Defu Li1 School of Economics and Management, Tongji University Benjamin Bental2 Department of Economics, University of Haifa Abstract What determines the direction of technological progress is one of the central questions that economics needs to answer. The current paper tries to answer this question by introducing a small but fundamental generalization of Acemolgu (2002). The extended model argues that although changing relative factor prices (as suggested by Hicks 1932) and the relative market size (as argued by Acemoglu 2002) indeed affect the direction of technological progress in the short run, in the long run that direction depends only on the relative supply elasticities of primary factors with respect to their prices. Moreover, it is biased towards enhancing the effectiveness of the factor with the relatively smaller elasticity. The troubling property of the neoclassical growth model discovered by Uzawa (1961), whereby balanced growth is reconcilable only with purely labor augmenting technological progress, is due solely to an implicit assumption that the capital supply elasticity is infinite. Key Words: direction of technological progress, steady-state, Uzawa’s theorem, investment elasticities, factor supply elasticities. JEL: O33;O41; E13;E25 We are grateful to Oded Galor, Daron Acemoglu and Ryo Horii for helpful comments and suggestions on previous versions of the paper. Li gratefully acknowledges support from the National Natural Science Foundation of China (NSFC:71773083), the National Social Science Foundation of China (NSSFC: 10CJL012). The authors take sole responsibility for their views. 1 School of Economics and Management, Tongji University, 1500 Siping Road, Shanghai, P.R. China, [email protected]. 2 Department of Economics, University of Haifa, 199 Aba Khoushy Ave., Mount Carmel, Haifa, Israel, [email protected]. 1 1. Introduction Technological change can equally increase the productivity of capital and labor, or it can be biased towards a specific factor. For example, according to Kaldor (1961), the stylized characteristics of economic growth in developed countries indicate that while per-capita output and physical capital have grown over time, the capital/output ratio and the income shares of labor and capital have remained basically constant since the industrial revolution.3 These facts have been interpreted as indicating that technological progress has been purely labor-augmenting. In contrast, Ashraf and Galor (2011) show that during the preindustrial era, technological progress has generated population growth and higher density, but not higher per-capita income, which may imply that during that period technological progress was in general not characterized by labor augmentation. Why is it that technological progress had hardly increased labor productivity during the preindustrial era but was focused on labor improvement afterwards? The neoclassical model obtains steady-state growth paths which are consistent with Kaldor’s stylized facts (Solow,1956; Cass,1965; Koopmans,1965). It does so by assuming that technological progress is purely labor-augmenting, but it cannot answer why technological progress must be purely labor-augmenting to exhibit that property.4 On the other hand, when technological progress is assumed to be purely land-augmenting, the Malthusian model’s balanced growth path is consistent with the historical facts confirmed by Ashraf and Galor (2011), but it also cannot explain why technological progress must not include labor-augmentation along a steady-state growth path.5 Moreover, neither of these models can answer the very same questions the other model answers. Acemoglu (2002, 2003) extends the technology of the Romer (1990) model 3These stylized characteristics are further supported by Jones (2015) using the latest available data. 4This problem has troubled growth economists for over half a century ever since the publication of Uzawa’s (1961) famous theorem (Jones and Scrimgeour, 2008; Acemoglu, 2009, pp.59). 5Li and Huang (2016) prove that there is a variant of Uzawa's steady-state theorem in a Malthusian setting. That is, if the model exhibits steady-state growth path, technical change must be purely land-augmenting and cannot include labor augmentation. 2 from one to two dimensions, thereby establishing a framework within which the determinants of the direction of technological progress can be analyzed. However, the model’s extreme restrictions on factor accumulation processes limit its ability to expose what we find to be the key determinants of the direction of technological progress. For the same reason it cannot reconcile the aforementioned discrepant characterizations of pre- and post-industrial revolution technological progress. By removing Acemoglu’s restrictions on the specification of the factor accumulation processes, the current paper not only identifies the determinants of the long-run direction of technological progress, but also provides simple and reasonable answers to the above questions. Specifically, we accept all of Acemoglu’s (2002, 2003) assumptions but allow investment elasticities in the two primary factor accumulation processes to range between 0 and 1, rather than being constrained at either boundary as is commonly done in the literature. This seemingly minor variation of the model is fundamental for analyzing the direction of technological progress. It demonstrates that it is just these elasticities that determine that direction in the long-run, while changes of relative factor prices (as suggested by Hicks 1932) and the relative abundance of these factors (as argued by Acemoglu 2002) impact only the short-run direction of technological progress. 6 Moreover, we show that technological progress is biased towards improving the exploitation of the factor with the relatively smaller elasticity. The intuition behind this result is the following. In the short run, a higher factor price encourages not only invention to economize that factor’s use, but also its accumulation. If the supply elasticity of the factor is very large, it may not be optimal to invest any resources in inventions that economize its use. Furthermore, to offset that factor’s abundance, balanced growth requires an increased investment in technologies that augment the efficiency of the factor with the smaller supply 6 The investment elasticities of the two primary factors in Acemoglu (2002) are set to zero. As a result, only Hick-neutrality is compatible with stationary equilibrium growth path; In Acemoglu (2003) and the neoclassical model the investment elasticity of capital is 1 and in the Malthusian model the investment elasticity of labor is 1. Therefore, in the steady state path, technological progress must be purely labor-augmenting for the former and purely land-augmenting for the latter. Removing these restrictions admits any combination of labor and capital augmentation along a steady-state growth path. 3 elasticity, leading to the extreme configurations of technological progress discussed above. To fix ideas, consider the case of oil. During a long period oil was abundant, and hardly any effort was put into economizing its use, as evidenced by the MPG figures of U.S. produced cars before the 1973 oil crisis. That crisis has caused a sharp increase in oil prices, inducing investment in energy-saving technologies (e.g., increasing MPG). However, the same price increase also induced search for new oil sources, such as shale oil. These new sources have again increased the supply of oil, contributing to sharp price decreases. Consequently, incentives to further invest in energy-saving technologies have decreased.7 With this intuition in mind, the paper suggests the following answers to the aforementioned questions. In the pre-industrial era technological progress did not increase labor productivity because labor supply was very elastic (as described by Malthus 1798). Approximately concurrent with the industrial revolution, the demographic transition reduced the supply elasticity of labor. Moreover, the industrial revolution has replaced land by reproducible physical capital. As the supply elasticity of capital increased, there were no incentives to economize on its use and improve its productivity. Consequently, technological progress was biased towards improving human capital, thereby increasing labor productivity. The ideas in this paper are closely related to previous literature dealing with the direction of technological progress. Over eighty years ago, Hicks (1932) wrote: “A change in the relative prices of the factors of production is itself a spur to invention, and to invention of a particular kind-directed to economizing the use of a factor which has become relatively expensive” (pp. 124-125). Hicks’ ideas were criticized by Salter (1960), basically arguing that since factors are paid the values of their marginal product, cost considerations alone cannot explain the direction of technological progress. 7 According to the PEW Environment Group, the model-year 1975 cars drove about 14 miles per gallon. This figure has doubled by 1985, and stayed roughly stagnant for the next two decades, rising to about 33 by 2005 (see http:// www. pewtrusts.org /~/ media /assets /2011 /04 /history- of -fuel -economy-clean-energy-factsheet.pdf). constructed 4 One important reason for the renewed interest in the direction of technological progress in 1960s was the publication of the aforementioned Uzawa (1961) steady-state
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